Qualified Zone Academy Bonds; Obligations of
States & Political Subdivisions

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [TD 8826] RIN 1545-AX23

TITLE: Qualified Zone Academy Bonds; Obligations of States and
Political Subdivisions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations that provide
guidance to state and local government issuers of qualified zone
academy bonds. These temporary regulations change the method of
ascertaining the qualified zone academy bond credit rate and provide
reimbursement rules. State and local governments that issue
qualified zone academy bonds will be affected by these temporary
regulations. The text of these temporary regulations also serves as
the text of the proposed regulations set forth in the notice of
proposed rulemaking on this subject in the Proposed Rules section of
this issue of the Federal Register.

DATES: Effective Date: These regulations are effective July 1, 1999.

Applicability Date: For dates of applicability, see §1.1397E-1T(j).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Timothy
L. Jones (202) 622-3980 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

Section 226(a) of the Taxpayer Relief Act of 1997, Public Law
105-34, (111 Stat. 788), amended the Internal Revenue Code by
redesignating section 1397E as 1397F and adding a new section 1397E.
Section 1397E authorizes a new type of debt instrument known as a
qualified zone academy bond. Temporary regulations interpreting
section 1397E were published on January 7, 1998 (63 FR 671).

Explanation of Provisions

In General

A qualified zone academy bond is a taxable bond issued by a state or
local government, the proceeds of which are used to improve certain
eligible public schools. In lieu of receiving periodic interest
payments from the issuer, an eligible holder of a qualified zone
academy bond is generally allowed annual federal income tax credits
while the bond is outstanding. These credits compensate the holder
for lending money to the issuer and function as payments of interest
on the bond.

Credit Rate

Under section 1397E(b)(2), the Secretary shall determine a credit
rate for qualified zone academy bonds that the Secretary estimates
will permit the bonds to be issued without discount and without
interest cost to the issuer. Section 1.1397E-1T(b) provides that the
credit rate for a qualified zone academy bond is equal to 110
percent of the long-term applicable Federal rate (AFR), compounded
annually, for the month in which the bond is issued.

Comments have been received that the credit rate established by
§1.1397E-1T(b) is generally lower than the rate required to permit
the issuance of qualified zone academy bonds without discount and
without interest cost to the issuer. Comments have also been
received that a single credit rate applicable to obligations issued
during a monthly period is too rigid and non-responsive to market
interest rate movements.

The revised regulations state that the Secretary will determine
monthly (or more often as the Secretary deems necessary) a credit
rate that will generally permit the issuance of qualified zone
academy bonds without discount and without interest cost to the
issuers. The revised regulations also provide that the manner for
ascertaining the credit rate determined by the Secretary will be set
forth in procedures, notices, forms, and instructions as prescribed
by the Commissioner. A notice to be published in the Internal
Revenue Bulletin will further provide that, until otherwise
provided, the qualified zone academy bond credit rate will be
determined daily and will be published on the Internet site for
State and Local Government Bonds. The credit rate to be applied to a
qualified zone academy bond will be the daily rate for the first day
on which there is a binding contract in writing for the sale or
exchange of the bond. Treasury and the IRS will monitor the issuance
of qualified zone academy bonds to determine if future adjustments
in the credit rate may be required.

Coordination with Reimbursement Rules

These temporary regulations provide that the proceeds of a qualified
zone academy bond may be used to reimburse a qualified expenditure
(including any qualified non-capital expenditure) made prior to the
date the bond was issued. The temporary regulations provide that
rules similar to the reimbursement rules set forth in §1.150-2 will
apply. Comments are solicited about whether these rules provide
adequate guidance regarding reimbursement matters for issuers of
qualified zone academy bonds.

Special Analyses

It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It has also been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6)
do not apply. See also the Special Analysis Section of the notice of
proposed rulemaking on qualified zone academy bonds in the Proposed
Rules Section of this issue of the Federal Register. Pursuant to
section 7805(f) of the Internal Revenue Code, these temporary
regulations will be submitted to the Chief Counsel for Advocacy of
the Small Business Administration for comment on its impact on small
business.

Drafting Information

The principal author of these regulations is Timothy L.

Jones, Office of Assistant Chief Counsel (Financial Institutions &
Products). However, other personnel from IRS and the Treasury
Department participated in their development.

List of Subjects in 26 CFR Part 1 Income taxes, Reporting and
recordkeeping requirements.

Adoption of Amendments to the Regulations Accordingly, 26 CFR part 1
is amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in
part as follows:

Authority 26 U.S.C. 7805 * * *

Par. 2. Section 1.1397E-1T is amended as follows:

1. Revising paragraphs (b) and (j);

2. Redesignating paragraph (h) as paragraph (i);

3. Adding new paragraph (h).

The revisions and additions read as follows:

§1.1397E-1T Qualified zone academy bonds (temporary).

* * * * *

(b) Credit Rate. The Secretary shall determine monthly (or more
often as deemed necessary by the Secretary) the credit rate the
Secretary estimates will generally permit the issuance of a
qualified zone academy bond without discount and without interest
cost to the issuer. The manner for ascertaining the credit rate for
a qualified zone academy bond as determined by the Secretary shall
be set forth in procedures, notices, forms, or instructions
prescribed by the Commissioner.

* * * * *

(h) Reimbursement. An expenditure for a qualified purpose may be
reimbursed with proceeds of a qualified zone academy bond.

For this purpose, rules similar to those in §1.150-2 shall apply.

* * * * *

(j) Effective dates. Except as provided in this paragraph (j), this
section applies to a qualified zone academy bond issued on or after
January 1, 1998. Paragraph (b) and paragraph (h) of this section
shall apply to a qualified zone academy bond sold on or after July
1, 1999. Paragraph (b) of this section as in effect on January 7,
1998 (See 26 CFR Part 1 as revised April 1, 1999), shall apply to a
qualified zone academy bond sold prior to July 1, 1999. This section
shall not apply to a qualified zone academy bond sold after January
5, 2001.

Deputy Commissioner of Internal Revenue
Robert E. Wenzel
Approved: June 22, 1999
Assistant Secretary of the Treasury (Tax Policy)
Donald C. Lubick

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